Stock Chartist

Commentary and recommendations about the stock market, sectors and individual stocks from a chartists perspective. Observations are based on the belief that "at their core, fundamentals are subjective but momentum is fact."

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April 23rd, 2012

Less than two weeks ago I wrote ““Identifying the Boundaries of Stock Chart Congestion Areas” in which I talked about three potential bottom boundaries of the congestion area that was developing and might eventually turn into a recognizable chart pattern. With time, the emerging chart pattern is becoming clearer and, I must add, a bit more worrisome.

The discussion of “boundaries” is actually at the core difference between fundamental and technical analysis. In fundamental analysis, analysts look at the slowing Chinese manufacturing index, Spanish debt refunding, elections in France and the upcoming U.S. elections, this quarter’s corporate earnings reports and the guidance for the year, upcoming Fed meetings, jobs reports, etc., etc. Those analysts would then attempt to distill and prioritize the voluminous and disparate data facts into a consistent picture. Finally, they will translate that picture into not what it means today, where it all might be headed in the future and what the impact might be on the stock market and individual stocks.

Needless to say, there are about as many divergent opinions about each of these data points as there are analysts willing to speak about them. Some of those opinions are meaningful and reliable while most are guess that are about as useful as yours or mine.

Technical analysts, on the other hand, focus more on the actual decisions continuously being made by millions of investors, whether rightly or wrongly, rather than the reasons for their having made them. They look at the continually changing balance (or imbalance) between supply (sellers) and demand (buyers) as reflected in transaction prices and volumes. The primary focus begins with whether that balance is shifting on a continuous basis in one direction or another because when that imbalance starts it tends to be self-perpetuating, reinforcing and continues for some time (i.e., momentum).

The market, after having risen nearly 30% since October, is currently almost perfectly balanced between buyers’ demand and sellers’ supply. Based on investors’ various interpretations of those fundamental facts, nearly an equal number see the facts portending a bearish future as those who see the facts leaning in a more bullish direction. In other words, about as many see the market glass as half-full as see it half-empty.

Our search for boundaries is an attempt to learn when that equilibrium balance starts tilting in one direction or another. Sometimes the balance continues for a few weeks and sometimes it takes months. In the last post, I inserted three possible bottom boundaries. As a result of today’s severe open, one of those supporting trendlines was penetrated; if there isn’t a quick strong bounce before the close and into tomorrow, then more downside can be expected. If the demand is insufficient to absorb the supply of those investors who see a pessimistic outlook then the market will break below both of the remaining support levels and will continue lower until a new equilibrium balance forms at lower levels.

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